Sunday, September 2, 2012

Alarming parallels between current Middle East tensions and events leading up to WWI

JPMorgan's commodities analysts draw some frightening parallels between the current Israel - Iran tensions (discussed here) and the events leading up to World War I. They first point out that since the tensions have not escalated into a military conflict so far, in spite of numerous predictions, the public has lost "interest" and the markets moved on to other issues. The web search interest for the phrase "iran war" has dropped off significantly since the peak of early 2012.

Source: Google Insights for Search

But that does not mean the risks have dissipated, particularly as Syria becomes a "wildcard".

JPM: In our view, the probability of a unilateral military strike by Israel against
Iran has increased from low single digits (2% to 5%) in January 2012 to
low double digits (10% to 15%) in August 2012. We think conventional
wisdom vastly overestimated this risk in 1H2012, lost interest when missile
volleys did not occur by June, and now underestimates the importance of
recent threats by the Israeli leadership and the soul-searching public
debate taking place within Israel about the wisdom of a preemptive strike.

Israel's highly "optimistic" assessment of the costs of such a conflict (see this article) ignores history and raises the possibility of a major strategic error.

JPM: - It is a red flag when any state claims a military conflict it unilaterally starts
will be contained to a short duration (30 days, say the Israelis) and limited
homeland casualties (500 dead). This bluster ignores important lessons
from history, such as are found in Barbara Tuchman’s masterpiece
analysis of the causes of World War I, The Guns of August. We spotlight
10 lessons from that analysis and how they apply to commodity risk today.

JPMorgan sees 10 parallels with the errors made during the period leading up to World War I (based on Barbara Tuchman’s The Guns of
August.)

JPM:... the principal lessons as we see them are:
(1) mobilization for war—“to send a message”—can create
unexpected momentum that results in a massive war no one
intended actually to start, (2) expectation for swift war can
be a tragic miscalculation, (3) casualties and human carnage
can be far higher than thought possible, (4) beware of
fighting the last battle—military planning based on historical
experience and stale assumptions leads to mistakes, (5) who
strikes first matters—global public opinion may turn against
the first striker, especially if that state tries to use subterfuge
to implicate wrongly its opponent as the first striker, (6) the
best laid plans are vulnerable to chaos, (7) unilateral actions
can be perceived as reckless, forcing surprising shifts in
formerly rock-solid alliances and forcing neutral sovereigns
into active engagement, (8) significant economic integration
is insufficient inoculation to prevent total war and
prosecution of war can persist even if it means economic
devastation, (9) appeals to national pride are insufficient to
prevent political backlash to and moral condemnation of
voluntary war, and (10) random events in proxy conflicts can
be the catalyst for general war.

The table below is an overview of these parallels as well as the actual outcomes of each of the decisions.

Source: JPM (click to enlarge)

Based on the fact that such a conflict risks becoming far broader and deadlier than the early assessments, JMorgan's view is that oil prices would spike initially but would then decline below current levels as global demand comes to a halt.

JPM: - It is a nearly universally held belief that an Israeli attack
must result in a large oil price spike, at least at first.
Markets seem to be ill-prepared for the very real potential
outcome that an attack could be followed by a strong
downdraft in petroleum prices, like the one that followed
Japan’s Tohoku earthquake last year, despite the loss of
1.2 mbd in Libyan crude output. If an attack occurred, we
would not be surprised if the initial impulse were a
smaller-than-expected and briefer-than-expected oil price
spike followed by a stronger-than-expected oil price
decline. ... [The decline would be driven by] large and unexpected damage to global
commodity demand, while simultaneously
boosting oil supply through release of
strategic oil stocks.